Guaranteed to fail

There are many reasons to be alarmed about the upcoming parliamentary elections. The possibility of eight, nine or even 10 parties entering Parliament after May 6 seems a recipe for a particularly unsatisfying political moussaka. The uncertainty over what the next government may look like or if cooperation will be feasible at all is also a cause for dread. The rise of the neofascist Chrysi Avgi is enough to make one sick to the stomach.

Even more alarming though is that with the elections about two weeks away, the political language is more wooden than the ancient fleet which saw off the Persians at Salamina. While Greek voters have largely been anesthetized to the effect of their politicians’ rhetoric, the fact that party leaders and parliamentary candidates are spending so much time locked in pointless debates means the crucial issues are being ignored.

It has now been well over a week since Prime Minister Lucas Papademos announced the snap elections and all the party leaders have had a chance to set out their positions and air their views in the media or at public rallies. None, though, has provided even an inkling of a comprehensive economic plan for Greece. Not one that is reliant on a smattering of European Union structural funds to bridge liquidity gaps but one that sets out a vision for how Greece can move forward over the next few years, on which sectors it needs to concentrate, how it will increase exports, how it will stop money leaving the country and how to harness the potential of its human resources.

PASOK leader Evangelos Venizelos has spoken of the need for a “national regeneration plan,” but for the moment it remains an empty structure. New Democracy chief Antonis Samaras has repeated calls for across-the-board tax cuts, but this also falls well short of the overarching scheme Greece needs. Other leaders have pointed to EU funds and revenues from possible gas and oil drilling as levers for growth.

None of this, though, is relevant to Greece’s immediate economic predicament, which is to create an environment in which businesses can be set up and then allowed to grow. For this to happen, two simple things are needed. The first is for these enterprises to have access to capital and the second is for the state to support them, or at least not stand in their way.

Yet hardly a word has been uttered by the election hopefuls about their plans for reducing bureaucracy. Their silence on the issue of business financing has been deafening.

Which leader, for instance, has set out a plan for how banks should operate following their recapitalization? Greek lenders are poised to receive some 50 billion euros of taxpayers’ money but nobody has drawn up a plan for how this money will be allocated, which businesses it will be used to support or on what terms it will be lent.

Greek banks, which announced substantial losses on Friday, appear unwilling to take the initiative on this, instead adopting a rather passive role. They seem reluctant to be agents of growth, preferring to wait or stability to be created by those around them. But even if this were not the case, the fact that public money is going toward keeping them on their feet means the political system has to create a clear funding policy, one that is fit for a changing economy.

Greek banks will also have to adapt with the times. They will no longer be able to rely on property or other assets against which to lend to entrepreneurs. They will have to learn to take the risk of lending to start-ups that are not guaranteed to succeed. They will have to find ways to stand by emerging small and medium-sized enterprises (SMEs).

Speaking at a conference in Athens on Friday, Papademos urged the banks to do more. “Banks have to take on an active role and assume their responsibilities and move quickly to use available funds and to finance businesses,” he said.

The conference, which focused on SMEs and entrepreneurship, heard of the difficulties that Greek businesses face. But it also heard how some people are triumphing despite the crisis, despite the lack of liquidity and despite the bureaucratic obstacles placed in their way. Since 2009, for example, the new information and communications technology (ICT) firms founded in Greece have generated 25 million euros of profits.

What Greeks should be hearing from their politicians is how these and other enterprises like them will be nurtured and allowed to grow. There is very little time left for strategies to be developed and it weighs particularly heavily on the two leaders vying to lead Greece to present a substantial scheme over the next few days.

Samaras is due to present his economic program on Sunday at Zappeio Hall. He must be hoping it will not go the way of the last two economic agendas he set out at the same location, which came to be known as Zappeio I and Zappeio II. A trilogy of failures would be a blow not just for the New Democracy leader but for Greece if, as opinion polls suggest, he is to have some part to play in the next government.

Venizelos, meanwhile, is also under pressure to get over his vagueness. At his first election rally on Thursday, he said that he “personally guarantees” Greece will recover from the crisis. These kinds of pledges belong to the past. They are guaranteed to bring nothing but failure.

22 responses to “Guaranteed to fail”

The lack of liquidity is due to Merkel’s PSI nonsense. The PSI evaporated overnight 85 – 90 Billion euro of combined Greek banking and social security (Asfakistika Tamia) assets.

In return, and in order to restore Tier 1 capital ratios ( EU mandated towards safe banking operations) some infusion of cash is given to the same banks, which however is not adequate to restore the level of Tier 1 deemed as minimum safety by the ECB.

So, the Greek banks are asked to find new sources of capital on their own and are given until September of 2012 to do so.

In such environment what you are asking is laughable. In essence what you are saying is that mortally wounded private banks while seeking to raise capital towards a minimum level of operational safety (mandated by the ECB), they ought to extend credit in an environment of extreme austerity and to clients that they neither have collateral nor borrowing credibility. This is like asking the police to offer free alcohol to motorists to expedite traffic accidents.

The issue of liquidity in Greece is a 100% EU political problem. Only the EU can decide when and how to turn on liquidity towards Greece for growth purposes. At such point, the Greek banks could become intermediary dispensers of such funds.

As it currently stands, Greek banks have received nothing yet. The 25 Bil. aimed at partial restoration is sitting at a Greek government account and will not be distributed until sometime in June. Notwithstanding that 85 Bil. was taken away and only 25 Bil is given back, if such funds were given to the banks directly from the ECB we would have a different story. But the ECB gave it to the government as leverage for continued political mischief.

Before asking the Greek banks to play a role in economic restoration you need to answer

a. what sort of extreme stupidity has dynamited the Greek banking system under the pretext of saving Greece a la Merkel and
b. how soon the Greek banks would be restored to relative safety (because all of them today are unsafe to operate, not of their own fault, but due to a contrived act of political amateurism called PSI).

Dean, liquidity has been a problem in Greece since at least early 2010. PSI happened a couple of months ago. Also, Greek banks have been receiving funds from the ECB through ELA since last year (https://insidegreece.wordpress.com/2012/03/05/ela-easy-as-abc/). I don’t think it helps to look at this just as a problem caused by PSI or the Europeans. The fact is that the Greek banks – albeit seriously troubled – are receiving money and are due to get another 50 billion but as a country, Greece has absolutely no plan for how this money should be used. For me, that is a bigger mistake than what has gone before.

I would agree with Dean everything he says but I believe everything happened due to lack of leaders in European Union and Greece. I believe François Hollande is a leader and if he is going to win the French Elections, European Union will have 3 different poles to afraid. 1 is France, 2. is Spain with its unstable moves and last is Greece with the Unexpected result from elections

Dean, your points are well taken but they are beside the point. The PSI caused book values to evaporate but not liquidity. The Greek banking sector has essentially unlimited funding from the ECB. The ECB announced recently that they would fund the Greek banking sector regardless what happens. So Greece doesn’t really have a real financial crisis yet. A real financial crisis is when foreign funding stops. In the last 2 years, Greece as a country could increase its foreign funding by over 100 BEUR. Should foreign funding stop, then a country has to overnight cut its imports and only then do you have a real crisis.

With all due respect, the sources I read say otherwise. I know you were in the banking sector and here are the results from the National Bank of Greece (the relative stongest of all Greek banks). It seems that the Tier 1 ratios are well below the mandated ratios. So the immediate concern of the Greek banks is not new lending but building up of defensive walls:

These are the 2011 for Bank of Greece and don’t include the full PSI effect yet. As you can see the Adequacy Ratios are well into the Red Zone:

The Total Capital Adequacy Ratio stands at 8.3%
following the state guarantee of a capital injection of
€6.9 billion from the Financial Stability Fund in the
context of the recapitalization programme for Greek
banks
 Core Tier I at 6.3%

Dean, we are getting side-tracked because the issue of this article is about economic plans for the future and not about spreading blame for the past. As you know from my posts in another blog, I am a fervent critic of Greek leadership (and Greek brainpower) that no one is coming up with economic plans for the future. The past is relevant only in as much as it helps designing better plans for the future. Blame distribution is a waste of time and energies.

I thought yesterday’s speech by Samaras was a rather good vote-getting speech but a real economic plan requires more than just saying “we will change everything”. The passion for privatization was impressive but when you propose a new tax on a company which is about to be privatized (OPAP), then you have just reduced the sales price of that company. And when you emphasize that you only want to privatize loss-makers, investors will not fall into euphoria. In short, my idea of an economic plan is different and this is where all the attention of Greek leadership should be put. Incidentally, after Samaras’ speech, I poured myself a little Ouzo and wrote this:

Having said this, let me briefly touch on our bilateral issue. The funding of Greek banks has been secured by the ECB, so there is no real worry to be had on the liability side of the balance sheet. The equity side is no major problem, either, because the EFSF is replenishing the equity wiped out through the PSI. The real problem are the capital adequacy ratios (not only for Greek banks; for all banks!). To increase capital adequacy ratios (Basel-III) during a recession is a wonderful recipe for disaster. The regulators probably hoped that banks would require state capital to meet the ratio so that politicians could intervene in bank policy to make loans. The bankers are now showing the regulators that one does not necessarily need new equity to increase the ratio. A reduction of assets will have the same effect. And that is what most of them are doing.

The real problem is that banks all over the place (not only Greece) don’t make loans to the real economy. Should not be too much of a surprise because Basel-II already had pro-cyclic risk management parameters. And with the capital adequacy ratios, banks now have even more of an incentive not to make such loans. The primary role of banks (at least in my mind) is to finance the real economy. Regulators have gotten banks to finance governments because they were classified as risk-free (no reserves required) whereas the real economy required risk reserves. How they are now going to get the banks to make loans to the real economy in a time of recession is going to be interesting to watch.

In my mind, the LTRO is primarily a vehicle to beef up the equity of banks. If you borrow at 1% and lend at 5%, you have a margin of 4%. That translates into new equity of 40 MEUR p.a. for every 1 BEUR you borrow from the ECB (unless it gets paid out as salaries & bonuses for executives…).

But Klaus, without being drawn into a long conversation (unless you enjoy it of course) please put on your hat as a banker for a second and then please answer this:

1. What criteria will you use in making new loans in Greece? From what I heard that bad loan provision in most banks is roughly 40% already.

2. The typical customer in Greece is an entity that wishes an immediate loan infusion to continue with operations. But neither the operations nor the business itself inspires any confidence in an environment of austerity. Lending to people with questionable business models (sometimes not of their own fault but due to the economic malaise hitting Greece) is not a prudent practice. All you are doing is provide a bit more fuel for the car to crash a few kilometers down the road.

3. Finally the issue of collateral in lending. Traditional collateral in Greece has been real estate. But the real estate market is beyond frozen. It’s the most illiquid market of all. What would a bank do in acquiring the fixed assets (including real estate) of a failing business? Where is the group of buyers for such and at what price? We now have a deathly spiral of ever decreasing collateral values and an illiquid disposition market to boot.
As an example – say you are a loan office that approves a loan based on an imputed collateral value. A month later the collateral value has gone down which means the safety ratios you used in approving the loan are no longer applicable. What banker in the world would approve a loan that within a short period of time the loan to value ratio is prohibitive?

In summary, you have a great deal of uncertainty in the Greek banking sector at the moment and uncertainty kills new lending. The recapitalization is not complete (perhaps after June) and with unknown yet terms, the banks have a substantial and rising provision for existing bad loans and you have an economy that is tanking. Neither one of the three conditions is conducive to new lending. Taken together, the 3 conditions above are a lender’s nightmare. The provide the textbook approach for not to lend.

Dean, you have just described why banks, reinforced by the pro-cyclical risk management paramaters of Basel-II, don’t want to make new loans in recessions. It’s the old complaint about banks that they are “selling umbrellas when the sun is out and run away as soon as the first rain drops fall”. Bankers are not bad people. Their behavior is determined by the incentives (or risk management parameters) they are given.

This is what happened in Germany in the 1990s/2000s: the state of the economy got worse and worse and banks lent less and less to the real economy (Mittelstand) and preferred to lend to sub-prime issuers, foreign governments, etc. Once the Agenda 2010 reforms started showing positive results, the economy improved and banks started making domestic loans again. And what we see now is the result of pro-cyclical incentives affecting bank behavior.

So if you fear that Greek banks will be hesitant to make new loans to the real economy, I can only say “You are damn right!” (and not only Greek banks). I worked in Germany during the 2000s. The government, the industry lobbies, everybody and his brother was pleading the German banks to make loans to the Mittelstand but only the local and regional banks complied a bit. Deutsche Bank, for one, declared publicly that their role couldn’t be to finance the risky German Mittelstand! To us as an Austrian bank (guided by somewhat different incentives) it was like Christmas and Easter at the same time: we didn’t even have to try to get new business; it walked through the door on its own! But mind you: the riskiness of the German Mittelstand, even in tough economic times, was still a lot better than what I expect the risk of Greek business to be like today.

One thing which was under considerations for Greece was to form a new economic development financer along the model of the German KfW. That might do some good if it is run well (and not like a public sector bank) but I don’t know whether that project is still alive.

But the same logic applies with austerity. Fiscal austerity is to be practiced during booming economic times not recessionary times. So the whole austerity medicine is wrong in Greece’s case.

You are asking me not to look at the past and focus on the future but what we have here is a Class A disaster due to human judgment error.

Regarding development in Greece, there are structural EU funds which in the past required 50/50 participation: 50% from the EU and 50% from the country (Greece in this case). But of course a bankrupt state can’t contribute 50% share. So the funding requirement has been revised to 90/10: 90% funding from the EU and 10% from Greece.

But even that is not enough. The real question is the type of projects. A prime example is the solar Helios project which is nothing more but a bad subsidy deal to the detrient of the public. Even Germany is lowering its energy tariffs for such projects and the Helios project is nothing more than a first generation technology which is already obsolete. The new photovoltaics with efficiencies of 60% or more (versus 10-12% today) are not even in the market yet. They are still in the labs of American Universities and National Laboratories like Argonne (www.anl.gov).

So the real question is lack of qualitative imperative in the growth arena. The only other area that I am aware of is natural gas fired electric plant construction receiving such funds. So other than a project here or there, where is fund absorption to come from?

I am fairly confident that if a list of qualified projects is selected and approved by the EU, Greek banks gladly will become intermediary dispensers of capital to such projects since they would carry the EU seal of approval. But what are they? Have you ever seen an enumeration (listing) of such projects? BTW, even if they exist, projects of this nature require specialized construction. So, the impact on the economy is fairly minimal since the majority of compensation goes to some heavily concentrated specialized groups of professionals and don’t necessarily spill to the rest of the economy.

Personally I am seek and tired of listening about Tourism as a lever of growth because tourism is clearly a discretionary spending item and even if a country has the best tourist facilities it does not mean the customers will be willing to pay for the service during frugal times such as the present.

So, you tell me: Where is immediate growth to come from? Down the road and in 10 years Greece might have a hydrocarbon economy due to potential Oil & Gas discoveries within its EEZ but this is not soon enough:

Dean, you know my argument where immediate growth (and new jobs) can come from: import substitution! How difficult can it be to (a) go down the list of imports; (b) identify those products where Greece has the capability to produce them (tongue in cheeck: start with agricultural products…); (c) set up the business framework in Special Economic Zones where they can be produced profitably; and (d) get started!
I am not the greatest fan of EIB for economies like Greece. At least in my time, the EIB was interested in larger infrastructure type of projects. Anything below 5 MEUR was too small for them. A few large infrastructure projects would certainly be help for Greece but those alone won’t turn the economy around. Also, with large projects you have large foreign sourcing, large procurements and everything else that goes with large procurements…
To me, the longer-term answer to the Greek economy can only be small to mid-size businesses; say 25-250 employees to name a figure. And in the sequence of events I would suggest the following:
1) start with import substitution because it works immediately and you get some breathing space.
2) then move on to export-oriented businesses where you also can accomplish something within a reasonable time span and gain more breathing space.
3) And, at the same time, use all that breathing space to really tackle the new-idea-businesses in new-idea-industries. That takes time but if you recall the McKinsey report, they talked about 500.000 new jobs through over 100 projects in 7 industries (and 50 BEUR GDP).
I share your views on Helios. In tough times, some people feel the urge to come up with Albert-Einstein-ideas which will create paradise on earth in no time. Helios might generate a lot of electricity but Germany has already announced that they would not pay more for Greek electricity than for the (already subsidized) German electricity. Kind of makes sense.
I do not share your views on austerity. Deficit spending loses impact when you are starting from a double-digit base. Also, I just don’t have much confidence in the Greek government to be an efficient reallocator of funding. So, I think austerity was (and is) necessary but it has to be the right kind of auterity and in Greece it was not, at least not todate.

So that you know. There have been some dramatic improvements in the export arena. Greek exports to China have increased by almost 90% year-over-year. The same with Turkey. Greece used to have a chronic export deficit with Turkey to the tune of 2:1 (Turkish imports being twice as high as exports). This has been turned completely around. We now have more than 2:1 advantage meaning Greek imports to Turkey are more than twice as high of Turkish exports to Greece. The balance of trade with this country alone represents more than 200+% improvement.

I expect the trade picture to further improve in 2012.

But such improvements can not keep up pace with the rapid destruction of the Greek economy due to the German error.

BTW, if you would want to immediately ban all imports of German products to Greece I will gladly support you. It’s the absolute minimum Merkel could do to compensate for the chaos she has created.

No, I do not recommend banning all imports of German products because I am sure there are essential ones among them and you would only hurt Greeks that way. Exports to Greece account for about 0,5% of total German exports, so you would hurt some individual large exporters (i. e. military equipment) but not the German economy overall.
Yes, exports have increased impressively in 2011 but I am sure that there is much more longer-term potential. Greece needs more of an export culture and a strong export lobby (I understand that presently Greece has a strong import lobby). Greece still imports way too much even though imports have declined significantly since the record level of 2008. The Bank of Greece says that the decline is due exclusively to the recession. Without structural reforms, import will explode again as soon as the economy picks up.
So, whichever way you slice it, the economy needs to be reformed to have a chance to be as successful as the Greek economy can or could be. I remember that American economists always calculated the unused potential of the US economy. I guess the equivalent number for Greece would be huge!

And to talk turkey here is an example of available programs through the EU bureaucracy. When and if the EU decides to facilitate such programs in Greece, the Greek banks will more than happy to oblige, meaning to become channels of capital provided and disbursed.

Don’t forget: one of the primary tasks of the EU Task Force is to get Greek projects into an “approvable” form. They say that over 10 BEUR are waiting to be disbursed to Greece and that they are working on almost 200 projects. We’ll see. This is only one of the reasons why I feel strongly that Greece should view the EU Task Force with great appreciation and not at all as an occupation force. The EU regional funds are certainly much more appropriate for Greece because they can be used for small and medium-size projects/businesses.

o.k. But the number of projects is not the real issue. It’s the quality and the underlying parameters of these projects. If all we are talking about is solar and wind subsidy nonsense installations then Greece is better off without such projects. The burden to the state is much greater than the benefit. When the whole world is trying to get to the target of energy cost less than 10 cents of KWH and Greece is undertaking burdens of 20-30 cents per KWH from such projects(through 25-year agreement) the result is regression not progress.